Must-Read: A paper that somehow seems to me to miss many of the important aspects of the situation. Where are home borrowers supposed to get their "rational expectations" of future house prices? Given that they are highly likely to be uninformed, should we really have a system in which households are betting large multiples of net worth in a market where they have no chance of being the smart money? That lots of other money wasn't smart either does not absolve mortgage regulators from blame. Not at all:
Why Did So Many People Make So Many Ex Post Bad Decisions? The Causes of the Foreclosure Crisis: "This paper presents 12 facts about the mortgage market...:
...The authors argue that the facts refute the popular story that the crisis resulted from financial industry insiders deceiving uninformed mortgage borrowers and investors. Instead, they argue that borrowers and investors made decisions that were rational and logical given their ex post overly optimistic beliefs about house prices. The authors then show that neither institutional features of the mortgage market nor financial innovations are any more likely to explain those distorted beliefs than they are to explain the Dutch tulip bubble 400 years ago. Economists should acknowledge the limits of our understanding of asset price bubbles and design policies accordingly.